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Robustness and Linear Contracts

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  • Gabriel Carroll

Abstract

We consider a moral hazard problem where the principal is uncertain as to what the agent can and cannot do: she knows some actions available to the agent, but other, unknown actions may also exist. The principal demands robustness, evaluating possible contracts by their worst-case performance, over unknown actions the agent might potentially take. The model assumes risk-neutrality and limited liability, and no other functional form assumptions. Very generally, the optimal contract is linear. The model thus offers a new explanation for linear contracts in practice. It also introduces a flexible modeling approach for moral hazard under nonquantifiable uncertainty. (JEL D81, D82, D86)

Suggested Citation

  • Gabriel Carroll, 2015. "Robustness and Linear Contracts," American Economic Review, American Economic Association, vol. 105(2), pages 536-563, February.
    • Handle: RePEc:aea:aecrev:v:105:y:2015:i:2:p:536-63
    Note: DOI: 10.1257/aer.20131159
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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